CPA ADVANCED FINANCIAL REPORTING
IFRS for Small and Medium-Sized Entities (IFRS for SMEs)
Small and medium-sized entities are entities that:
(a) Do not have public accountability, and
(b) Publish general purpose financial statements for external users. Examples of external users include owners who are not involved in managing the business, existing and potential creditors, and credit rating agencies. General purpose financial statements are those that present fairly financial position, operating results, and cash flows for external capital providers and others.
An entity has public accountability if:
- (a) its debt or equity instruments are traded in a public market or it is in the process of issuing such instruments for trading in a public market (a domestic or foreign stock exchange or an over-the-counter market, including local and regional markets), or
- (b) it holds assets in a fiduciary capacity for a broad group of outsiders as one of its primary businesses. This is typically the case for banks, credit unions, insurance companies, securities brokers/dealers, mutual funds and investment banks. If an entity holds assets in a fiduciary capacity as an incidental part of its business, that does not make it publicly accountable. Entities that fall into this category may include public utilities, travel and real estate agents, schools, and charities.
Features of an SME
- Require relatively small capital investment to start.
- Offer relatively high labour to capital ratio.
- Improve forward and backward linkages between conomically, socially and geographically diverse sectors.
- Breeding ground for entrepreneurial talent.
- Act as ancillaries to large industries.
- Serve as training ground for local skills and entrepreneurs.
- Highly flexible operations.
- Positioned to absorb business shocks and adjust to business cycle.
- Usually sole proprietorships, partnerships entrepreneurs
- Labour intensive production processes
- Centralised management
Section-by-Section Summary of the IFRS for SMEs
- The IFRS for Small and Medium-sized Entities is organized by topic, with each topic presented in a separate section. All of the paragraphs in the standard have equal authority.
- The standard is appropriate for general purpose financial statements and other financial reporting of all profit-oriented entities. General purpose financial statements are directed towards the common information needs of a wide range of users, for example, shareholders, creditors, employees and the public at large.
- The IASB intends to issue a comprehensively reviewed standard after two year’s implementation, to address issues identified and also, if appropriate, recent changes to full IFRSs. Thereafter, an omnibus proposal of amendments will be issued, if necessary, once every three years.
Benefits of IFRs for SMEs
- Improved access to capital
- Improved quality and comparability of reporting
- Facilities cross-border trading
- Focus on the needs of users of SME financial statement
- Audit efficiencies.
- Stability – initial 2 year comprehensive review followed by 3-year omnibus updates.
- Eases burden where full IFRS has previously been required
- Stepping stone to full IFRS for private entities aiming for initial offering (IPO)
Challenges facing implementation of IFRS
- Learning new technologies and accounting techniques
- Making changes to information systems and accounting software may be needed
- Collecting additional data for some transactions.
- Dealing with new concepts.
- Dealing with valuation issues
Concepts and Pervasive Principles
- Objective of SMEs’ financial statements: To provide information about financial position, performance, cash flows
- Also shows results of stewardship of management over resources
- Qualitative characteristics (understandability, relevance, materiality, reliability, substance over form, prudence, completeness, comparability, timeliness, balance between benefit and cost)
- Asset: Resource with future economic benefits
- Liability: Present obligation arising from past events, result in outflow of resources
- Income: Inflows of resources that increase equity, other than owner investments
- Expenses: Outflows of resources that decrease equity, other than owner withdrawals
- Financial position: the relationship of assets and liabilities at a specific date
- Performance: the relationship of income and expenses during a reporting period
- Total comprehensive income: arithmetic difference between income and expenses
- Profit or loss: arithmetic difference between income and expenses other than those items of income or expense that are classified as ‘other comprehensive income’.
- There are only 3 items of other comprehensive income (OCI) in the IFRS for SMEs:
- Some foreign exchange gains and losses relating to a net investment in a foreign operation (see Section 30)
- Some changes in fair values of hedging instruments – in a hedge of variable interest rate risk of a recognised financial instrument, foreign exchange risk or commodity price risk in a firm commitment or highly probable forecast transaction, or a net investment in a foreign operation (see Section 12) (Note that hedge accounting is optional)
- Some actuarial gains and losses (see Section 28) (Note that reporting actuarial gains and losses in OCI is optional)
- Basic recognition concept – An item that meets the definition of an asset, liability, income, or expense is recognised in the financial statements if:
- it is probable that future benefits associated with the item will flow to or from the entity, and
- the item has a cost or value that can be measured reliably
- Basic measurement concepts
- Historical cost and fair value are described
- Basic financial assets and liabilities are generally measured at amortised cost
- Other financial assets and liabilities are generally measured at fair value through profit or loss
- Non-financial assets are generally measured using a cost-based measure
- Non-financial liabilities are generally measured at settlement amount
- This Section includes pervasive recognition and measurement principles
- Source of guidance if a specific issue is not addressed in the IFRS for SMEs
- Concepts of profit or loss and total comprehensive income
- Offsetting of assets and liabilities or of income and expenses is prohibited unless expressly required or permitted
Financial Statement Presentation
The following fshould be prepared
Statement of Financial Position
- May still be called ‘balance sheet’
- Current/non-current split is not required if the entity concludes that a liquidity approach produces more relevant information
- Sequencing, format, and titles are not mandated
Statement of Comprehensive Income and Income Statement
- One-statement or two-statement approach – either a single statement of comprehensive income, or two statements: an income statement and a statement of comprehensive income
- Must segregate discontinued operations
- Must present ‘profit or loss’ subtotal if the entity has any items of other comprehensive income
- Bottom line (‘profit or loss’ in the income statement and ‘total comprehensive income’ in the statement of comprehensive income) is before allocating those amounts to non-controlling interest and owners of the parent
- No item may be labelled ‘extraordinary’
- But unusual items can be separately presented
- Expenses may be presented by nature (depreciation, purchases of materials, transport costs, employee benefits, etc) or by function (cost of sales, distribution costs, administrative costs, etc) either on face of the statement of comprehensive income (or income statement) or in the notes
Statement of Changes in Equity and Statement of Comprehensive Income and Retained Earnings
- Shows all changes to equity including
- total comprehensive income
- owners’ investments
- owners’ withdrawals of capital
- treasury share transactions
- Can omit the statement of changes in equity if the entity has no owner investments or withdrawals other than dividends and elects to present a combined statement of comprehensive income and retained earnings
Statement of Cash Flows
- Presents information about an entity’s changes in cash and cash equivalents for a period
- Cash equivalents are short-term, highly liquid investments (expected to be converted to cash in three months) held to meet short-term cash needs rather than for investment or other purposes
- Cash flows are classified as operating, investing, and financing cash flows
- Option to use the indirect method or the direct method to present operating cash flows
- Interest paid and interest and dividends received may be operating, investing, or financing
- Dividends paid may be operating or investing
- Income tax cash flows are operating unless specifically identified with investing or financing activities
- Separate disclosure is required of some non-cash investing and financing transactions (for example, acquisition of assets by issue of debt)
- Reconciliation of components of cash
Notes to the Financial Statements
- Notes are normally in this sequence:
- Basis of preparation (ie IFRS for SMEs)
- Summary of significant accounting policies, including
- Information about judgements
- Information about key sources of estimation uncertainty
- Supporting information for items in financial statements
- Other disclosures
- Comparative prior period amounts are required by Section 3 (unless another section allows omission of prior period amounts)
Consolidated and Separate Financial Statements
- Consolidated financial statements are required when a parent company controls another entity (a subsidiary).
- Control: Power to govern financial and operating policies to obtain benefits
- More than 50% of voting power: control presumed
- Control exists when entity owns less than 50% but has power to govern by agreement or statute, or power to appoint majority of the board, or power to cast majority of votes at board meetings
- Control can be achieved by currently exercisable options that, if exercised, would result in control
- A subsidiary is not excluded from consolidation because:
- Investor is a venture capital organisation
- Subsidiary’s business activities are dissimilar to those of parent or other subs
- Subsidiary operates in a jurisdiction that imposes restrictions on transferring cash or other assets out of the jurisdiction
- However, consolidated financial statements are not required, even if a parent-subsidiary relationship exists if:
- Subsidiary was acquired with intent to dispose within one year
- Parent itself is a subsidiary and its parent or ultimate parent uses IFRSs or IFRS for SMEs
- Must consolidate all controlled special-purpose entities (SPEs)
- Guidance on separate financial statements (but they are not required).
- In a parent’s separate financial statements, it may account for subsidiaries, associates, and joint ventures that are not held for sale at cost or fair value through profit and loss.
- Guidance on combined financial statements (but they are not required)
- If investor loses control but continues to hold some investment:
- If the subsidiary becomes an associate, follow
- If the subsidiary becomes a jointly controlled entity,
- If investment does not qualify as an associate or jointly controlled entity, treat it as a financial asset
Liabilities and Equity
- Guidance on classifying an instrument as liability or equity
- An instrument is a liability if the issuer could be required to pay cash
- Puttable financial instruments are only recognised as equity if it has all of the following features:
- The holder is entitled to a pro rata share of the entity’s net assets in the event of liquidation.
- The instrument is the most subordinate class.
- All financial instruments in the most subordinate class have identical features.
- Apart from the puttable features the instrument includes no other financial instrument features.
- The total expected cash flows attributable to the instrument over the life of the instrument are based substantially on the change in the value of the entity.
- Members’ shares in co-operative entities and similar instruments are only classified as equity if the entity has an unconditional right to refuse redemption of the members’ shares or the redemption is unconditionally prohibited by local law, regulation or the entity’s governing charter. If the entity could not refuse redemption, the members’ shares are classified as liabilities.
- Covers some material not covered by full IFRSs, including:
- original issuance of shares and other equity instruments. Shares are only recognised as equity when another party is obliged to provide cash or other resources in exchange for the instruments. The instruments are measured at the fair value of cash or resources received, net of direct costs of issuing the equity instruments, unless the time value of money is significant in which case initial measurement is at the present value amount. When shares are issued before the cash or other resources are received, the amount receivable is presented as an offset to equity in the statement of financial position and not as an asset. Any shares subscribed for which no cash is received are not recognized as equity before the shares are issued.
- sales of options, rights and warrants
- stock dividends and stock splits – these do not result in changes to total equity but, rather, reclassification of amounts within equity.
- ‘Split accounting’ is required to account for issuance of convertible instruments
- Proceeds on issue of convertible and other compound financial instruments are split between liability component and equity component. The liability is measured at its fair value, and the residual amount is the equity component. The liability is subsequently measured using the effective interest rate, with the original issue discount amortized as added interest expense.
- A comprehensive example of split accounting is included
- Minority interest changes that do not affect control do not result in a gain or loss being recognised in profit and loss. They are equity transactions between the entity and its owners.
- Dividends paid in the form of distribution of assets other than cash are recognised when the entity has an obligation to distribute the non-cash assets. The dividend liability is measured at the fair value of the assets to be distributed.
- Revenue results from the sale of goods, services being rendered, construction contracts income by the contractor and the use by others of your assets
- Some types of revenue are excluded from this section and dealt with elsewhere:
- dividends from equity accounted entities
- changes in fair value of financial instruments
- initial recognition and subsequent re-measurement of biological assets and initial recognition of agricultural produce
- Principle for measurement of revenue is the fair value of the consideration received or receivable, taking into account any possible trade discounts or rebates, including volume rebates and prompt settlement discounts
- If payment is deferred beyond normal payment terms, there is a financing component to the transaction. In that case, revenue is measured at the present value of all future receipts. The difference is recognised as interest revenue.
- Recognition – sale of goods: An entity shall recognise revenue from the sale of goods when all the following conditions are satisfied:
(a) The entity has transferred to the buyer the significant risks and rewards of ownership of the goods.
(b) The entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold.
(c) The amount of revenue can be measured reliably.
(d) It is probable that the economic benefits associated with the transaction will flow to the entity.
(e) The costs incurred or to be incurred in respect of the transaction can be measured reliably.
- Recognition – sale of services: Use the percentage of completion method if the outcome of the transaction can be estimated reliably. Otherwise use the cost-recovery method.
- Recognition – construction contracts: Use the percentage of completion method if the outcome of the contract can be estimated reliably. Otherwise use the cost-recovery method.
- Recognition – interest: Interest shall be recognized using the effective interest method
- Recognition – royalties: Royalties shall be recognized on an accrual basis in accordance with the substance of the relevant agreement.
- Recognition – dividends: Dividends shall be recognized when the shareholder’s right to receive payment is established.
- Appendix of examples of revenue recognition under the principles
- Award credits or other customer loyalty plan awards need to be accounted for separately. The fair value of such awards reduces the amount of revenue initially recognized and, instead, is recognized when awards are redeemed.
Transition to the IFRS for SMEs
- First-time adoption is the first set of financial statements in which the entity makes an explicit and unreserved statement of compliance with the IFRS for SMEs: ‘…in conformity with the International Financial Reporting Standard for Small and Medium-sized Entities’.
- Can be switching from:
- National GAAP
- Full IFRSs
- Or never published General Purpose Financial Statements in the past
- Date of transition is beginning of earliest period presented
- Select accounting policies based on IFRS for SMEs at end of reporting period of first-time adoption
- Many accounting policy decisions depend on circumstances – not ‘free choice’
- But some are pure ‘free choice’
- Prepare current year and one prior year’s financial statements using the IFRS for SMEs
- But there are many exceptions from restating specific items
- Some exceptions are optional
- Some exceptions are mandatory
- And a general exemption for impracticability
- All of the special exemptions in IFRS 1 are included in the IFRS for SMEs